China’s real estate market: pulling the rug out from under the citizenry

(June 8, 2011) In China, owning a home is a dream and keeping a home from being destroyed, near impossible.

By You Chenli

Home sweet home? There’s no such thing in a land where householders cannot buy to own or even keep what’s theirs if the state wants it, reveals You Chenli.

In recent years, housing has become China’s hottest topic. Prices have increased dramatically across the country. For instance, in Beijing, the average price per square meter increased from RMB 4,000 in 2004 to RMB 30,000 in 2010. But this rise in value has been accompanied by massive disruptions caused by house demolitions and land expropriation. It may well seem an odd thing to destroy houses just when they are becoming more valuable but the rationale is actually a rather simple one: municipal governments are profiting from land speculation.

Expropriation is rampant in China. Based on incomplete statistics, more than half of the country’s cases on appeal to upper and central authorities are related to housing and land expropriations. There are several notorious and pernicious cases that illustrate the seriousness of this issue. In June of 2008, a homeowner from the Min Xing District named Pan Rong used a homemade grenade to defend herself against a bulldozer tearing down her house without her permission. In November of 2009, Tang Fuzhen, a 47 year-old resident of Chengdu City, set herself on fire while standing on the roof of her house: a desperate protest over the compulsory destruction of her home. In March 2010, an old woman from Wuhan City, the capital city of Hubei Province, was buried alive when a wrecking crew set to demolishing her home. She did not survive. And in May, 2010, to protect his farmland from occupation, an old farmer used a homemade cannon to defend his property against the government authorities trying to destroy it.

Although these events drew attention to the issue of housing expropriations, they failed
to slow down their increasing speed. In July of 2010, the Institute of Mechanics at the
Chinese Academy of Sciences – a state-owned research department – was bulldozed
to the ground. In October 2010, a PhD student at Fudan University in Shanghai kept a
diary to document his father’s death at the hands of a wrecking crew. In November of
2010, a PhD law student from Tsinghua University wrote a long letter to the mayor of his
hometown protesting the destruction of his home – the first citizen to use their knowledge
of law to argue against the destruction of their family’s property. Then in December, the
Qian Yunhui case occurred. Qian, the head of a village in Wenzhou City located in the
east of Zhejiang Province, was trampled to death by a heavy truck. Although this was
ruled a traffic accident by officials, local farmers argued that he was killed intentionally
by the government because of his unyielding opposition to the expropriation of farmland
in the area, including his own. This event nearly tore the village apart.

But why are the prices of houses in China so high, and why are there so many conflicts
between residents and officials over home expropriations? There are many factors that
need to be explained. Let me start with the reason why housing prices are so high.

The conflict between demand and supply

The basic reason for sky-rocketing housing and land costs is the mismatch between
supply and demand. The demand for houses in China is very high for two reasons. After
more than 30 years of economic growth and rising incomes, Chinese people are focused
on improving their standard of living and that means upgrading their homes. This trend
has been particularly pronounced in recent years, since the second generation of the 1950s baby boom reached marriageable age (22 for men, 20 for women). According to the traditional culture of China, most newlyweds feel compelled to buy houses to establish a new family. The second reason for escalating prices is simply inflation. And, the third reason is a lack of alternative investment options, making real estate the investment of choice.

However, the surge in demand is not enough to explain the unbelievable increase in real estate prices. The crucial factor driving the increase is the shortage in supply, which is itself the result of China’s “City Land Reserve System”. This system allows the government to prevent huge amounts of land from being used for development, and makes land artificially scarce and expensive. Empowered by this system, local governments are able to earn far more when they allow sales from reserve land than they would by relinquishing control of its supply. Although the system seems illogical, it owes its existence to the lack of private property rights. Governments have such huge incentives to keep land prices high they will do barbaric things to drive up their revenue. To illustrate the immensity of the problem, I will provide a brief institutional and historical background.

Citizens without property rights and the abuse of power by monopoly government

I’ll begin with the history of property rights in China after the establishment of the People’s Republic of China in 1949. In the cities, land used to belong to private owners, even in the immediate years following 1949. After the socialist transformation between 1953 and 1956, many private houses were taken by the government and reallocated to constantly immigrating city dwellers. During the 10 years of China’s Cultural Revolution, the original ownership of property and land deeds was confiscated by the government. When the revolution ended, property (along with deeds) was supposed to return to the original owners but this was in reality, a rare event. A short time later, China began its period of rapid development and started demolishing old houses to make way for new ones, along with the creation of new cities.

Many private owners tried their best to protect their property, but they were not even
allowed hearings before their houses were torn down. And because they did not possess
the deeds to their homes or their land – this documentation remained in the possession of the government – lawsuits against the state proved futile.

In rural areas, after 1949, farmland was distributed by the government. Then, between 1953 and 1956, farmland was expropriated again by the government for the Great Leap Forward in 1958. Almost all Chinese farmers lost their property rights during this time. In the absence of property rights, communal ownership of property – including houses, farmland and all the food produced – led to a reduction in grain production. This1 caused China’s “Great Famine” from 1959 until 1961. Afterwards, farmers were granted limited rights to their own private plots.

While the 10-year Cultural Revolution did nothing to stabilize the security of property rights it did not, at least, lead to a second famine. From 1978 onwards, reform policies gave farmers contracting rights to farmland. But although farmers now had land on which to build homes, they did not enjoy full right of ownership to either the homes they built or the land on which they built them.

At present, the underlying problem remains one of ownership: all land and houses in China by law belong to the state and not individuals. Farmers only have contracting rights to farmland for a few years. Urban residents can only own 70-year leases on their houses and the land beneath them. They may renew rights to these leases, at least for the time being, but no one knows what will happen to these rights in the future. What everyone does know is that urban and rural planning law permits the government to demolish any house and expropriate any property it deems is in the “public interest.” In fact, governments across the country at all levels use legal loopholes to reserve land at low cost, which government officials then sell for an exorbitant profit, which they pocket. This is also the reason why government employees are able to occupy private houses and lands all over China unscrupulously and free from legal sanction.

Tax-Sharing Reform and Land Finance

But what incentives are driving governments to demolish houses and expropriate land?
To answer that question, we need to look at which level of government profits most from
these actions: local government. In 1994, China’s tax system was overhauled. Before this
change, the central government was the much poorer cousin of local government. Policy
reform increased the center’s administrative powers and enabled it to take a bigger share
of tax revenues. The central government increased its wealth and downloaded public
responsibilities, such as education and health-care, to local governments. In order to earn
more money to fulfill public obligations, local governments decided that boosting the
value of land would make up for the shortfall. Admittedly, the great private interests of some local officers and businessmen are also big incentives and have caused a dramatic rise in the demolition of homes and land expropriations. Local governments have been able to exploit the country’s Urban and Rural Planning Law – established to promote urban-rural integration2 – to demolish houses whose owners did not have access to full property rights. Then they sold this land to developers for around 100 times more than they paid the original owners. Local governments not only now derive more than 60% of their total income annually from land sales; they pursue land-grab policies more aggressively each year in order to drive up the price of real estate in order to earn more revenue.

Local governments are indeed the real drivers of China’s soaring real estate costs. Given that the real estate market is the most important source of income for local government in China, a real estate collapse would utterly bankrupt them. The central government is desperately trying to avoid this and is attempting to stabilize housing prices. But if the central government does not also cut its budget and shift some taxing powers to municipalities, they will have to choose between cooling down the real estate market and bankrupting local government.

Their moves to tame the real estate market are little more than a show for the public,
in any case. What I should also mention here is that although the banks may face some
risks, the fact that they are owned by the state makes them different from banks in
developed countries. Because of this, the Chinese government can still use money from
taxes to cover bank losses as a result of housing defaults.

Conclusion

The high cost of real estate and rampant expropriations are the unintended consequences
of the lack of private property rights and the taxation policies of China’s central government. Local government, and not business developers or real estate speculators, are the drivers of these problems.

The people of China need both central and local government to come together to cut
the cost of housing and end land expropriation. But unless the central government
reforms the country’s tax system, lowering property prices would mean suicide for local
administrations. As such, there is little cause for optimism. Land battles between citizens
and the state will likely continue.

You Chenli is a researcher with the Transition Institute. You investigates and reports on regulated industries in China. His goal is deregulation and the establishment of free markets in China. He is also the chief writer and editor of the Transition Institute’s recent reports on China’s taxi industry. You is a commentator on various issues for China’s top media outlets. You Chenli can be reached via email at:youchenli@gmail.com.

1 China’s Great Famine in the years between 1958 and 1961 killed between 15 and 35 million people. While the Chinese government’s stance is that the famine was largely a result of a series of natural disasters, researchers agree that massive institutional and policy changes to collectivize farms and food production during the Great Leap Forward were the true causes of the famine.

2 Put into practice from January, 2008. It was created to strengthen the management of urban and rural planning, the spatial arrangement of urban and rural areas, and improve the economic and social environment, as well as promote sustainable development.